Investment Appraisal Techniques Flashcards
What are the disadvantages of the payback method?
Short termist.
Choice or target payback period Is subjective.
Ignores time value of money.
How is ARR calculated?
Average annual accounting profit/initial investment x100
Average annual accounting profit/average investment x100
What are the advantages of the payback method?
Simple to understand.
Useful as initial screening technique.
Useful if future is uncertain.
What are the advantages of the ARR method?
Quick and simple.
Recognises profits from the financial statements.
What are the disadvantages of the ARR method?
It’s a relative measure which ignores the size of projects.
Accounting profit can be manipulated.
Ignores timing of profits as it uses average.
Ignores the time value of money.
What are the advantages of NPV?
Directly links to absolute increase in shareholder wealth.
Considers all relevant cash flows through the time value of money.
Can incorporate risk through changes in “r”
How is the present value of perpetuity per annum calculated?
Cash flow x 1/r
How is the internal rate of return calculated?
IRR = a + NPVa/NPVa-NPVb x(b-c)
How is perpetuity factor calculated?
1/discount
How is perpetuity calculated?
